Real estate developers routinely use tax-exempt bond financing for infrastructure improvements for new communities. That may change soon. IRS perceives abuse in the process, and has proposed regulations making such bonds taxable if the developer controls the issuing governmental body.
Using enabling statutes under state law, a developer can initiate creation of a governmental body with the power to issue bonds secured by the developer’s land. Although other types exist, Community Development Districts (often called “CDDs”) are the most common governmental body formed this way in Florida.
Such governmental bodies have historically qualified to issue municipal bonds exempt from federal income tax. Because investors demand a lower absolute interest rate from tax exempt bonds than taxable bonds, these structures allow developers to enjoy a lower financing cost than would otherwise be the case.
The governing officials for such bodies usually are elected through a voting process weighted based on land ownership. In the early phases of development, the developer owns most or all of the land, and therefore controls the governmental body. When the neighborhood is closer to completion–and end-users have purchased lots and other developed property–the developer loses control, and the new property owners oversee the governmental body.
The problem with the IRS proposed regulations is that the developer always controls the governmental body when making the initial infrastructure improvements–such as roads and utility infrastructure–for a community. At that time, there is no community in which end users can buy lots, homes, or other property. By prohibiting developer control, the proposed regulations could eliminate–or severely restrict–this form of financing.
The IRS is considering taxpayer comments suggesting an exemption from the new rules for early-stage developments under developer control. This may provide a middle ground that limits abuse, but permits legitimate infrastructure improvements by governmental bodies that are reasonably expected to eventually be controlled by a widely disbursed group of end-user owners. As usual, the devil is in the details. For example, it may be difficult to fit larger, multi-phase communities within such rules. Unfortunately, with these proposed regulations, the IRS has put the burden on taxpayers, rather than itself, to design a workable framework. Comments are due to IRS by May 23.
Here is a link to the proposed regulations: https://www.irs.gov/irb/2016-10_IRB/ar17.html